Russia - Overview of economy

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Russia today has a diversified economy, but its most important sector is
the sale of raw materials and
primary commodities
such as oil, timber, and gold. Russia is well-endowed with natural
resources and raw materials. Russia ranks among the world's
leading producers of petroleum and gas, copper, manganese, bauxite,
graphite, uranium, titanium, gold, silver, and platinum. The former
Soviet Union was a leading international producer of manufactured items
such as chemicals, weapons, and military and aerospace equipment. Much
of the industrial base of these manufacturing sectors was located within
the Russian Republic itself. However, the disintegration of the USSR led
to significant interruptions in commercial relationships.

During its 73 years of existence, the USSR grew to be a great military
superpower. Measured in terms of crude output, the USSR created the
foundation for massive production possibilities. The USSR became one of
the world's largest producers of numerous processed materials and
manufactured items, ranging from foodstuffs to nuclear warheads. But
efficiency of production—that is the ratio of inputs to outputs
for any given product— was not a major objective of the Soviet
economic system. Great emphasis was put on outputs. Accordingly, the
USSR developed an economic system that was focused almost exclusively on
the achievement of production targets. The system proved to be extremely
bureaucratic and highly resistant to technological change. The Soviet
economic system was not capable of meeting the requirements of the
dynamic international markets of the 21st century. Even before the
Soviet Union broke up, the Russian government began initiating reforms
to move the economy from a centrally-planned to a market-based
liberal economy
. This process of change has come to be known as the transition to a
market economy.

Soon after independence, the Russian government announced a much more
ambitious program of political and economic reform. The program included
a transformation of the economy from the principles of state planning
and administrative direction to market-based economics.
Price controls
were lifted. Government
subsidies
were eliminated or reduced. The government budget was organized along
new lines so that it could be balanced through bringing tax revenues
into line with government spending. A restrictive
monetary policy
was adopted. Foreign trade was
liberalized
through the lifting of export and import controls. The Russian
currency, the ruble, was allowed to devalue to bring it into line with
market rates.
Privatization
and
restructuring
of state
monopolies
was undertaken. Efforts were commenced to establish the legal and
regulatory structure for a market environment. New legislation was
passed to establish laws and procedures for the banking industry,
capital markets, civil and contract law, adjudication of commercial
disputes, and the development of a social safety net to cushion the
social impact of economic structural transformation.

But the first years of transition proved very difficult for Russia. In
its first decade as a market-oriented economy, the Russian economy
suffered a contraction of nearly 60 percent over pre-independence levels
as measured by GDP. Sharp declines in production in key industries and
exports led to a continuously contracting economy between 1990 and 1997
as industrial production went into a "free fall," dropping
more than 50 percent during the decade of the 1990s. The Soviet
military-industrial complex, suppliers of goods to the state sector, and
light industry were the hardest hit by the structural adjustment to a
market-oriented economy and the withdrawal from superpower status.

In 1997 the economy began to show the first signs of post-transition
recovery, posting a growth rate of slightly less than 1 percent. Despite
the "shock therapy" of a rapid transition and the decline
in industrial production, increase in poverty and unemployment, and the
weakening of the social service
infrastructure
, Russia was beginning to show signs of an economic turnaround.
Inflation
, which skyrocketed in 1993 and 1994, finally had been brought under
control. The ruble was stabilized. An ambitious privatization program
had transferred thousands of enterprises to private ownership. Important
market-oriented laws had also been passed, including a commercial code
governing business relations and the establishment of an arbitration
court for resolving economic disputes.

However, in the summer of 1998, a powerful wave of financial instability
that originated in the Asian financial crisis of 1997 swept through the
Russian financial community. The Russian economy has undergone
tremendous stress as it has moved from a
centrally-planned economy
toward a
free market system
. Difficulties in implementing fiscal reforms aimed at raising
government revenues and a dependence on short-term borrowing to finance
government
budget deficits
led to a serious financial crisis in 1998. Lower prices for
Russia's major export earners (oil and minerals) and a loss of
investor confidence due to the Asian financial crisis exacerbated
financial problems. The result was a rapid decline in the value of the
ruble, flight of foreign investment, delayed payments on government and
private debts, a breakdown of commercial transactions through the
banking system, and the threat of runaway inflation. In August 1998 the
Russian government allowed the ruble to fall precipitously and postponed
payment on US$40 billion in treasury bonds. In the wake of the financial
crisis, billions of dollars of
foreign direct investment
were swept out of the country, investor confidence fell, and Russia
moved into a sharp economic contraction.

The 1998 financial crisis produced a steep and sudden decline in
personal incomes, as
GDP per capita
in Russia dropped from US$3,056 in 1997 to US$1,867 in 1998. The sharp
decline in per capita income and contraction of the financial markets
also had some benign effects, however. In some economic sectors, Russian
economic performance improved as higher world prices for
fuels—world oil prices nearly tripled in 1999—and some
metals facilitated improvement in exports. The Russian ruble was
devalued in connection with the financial crisis. The devalued ruble
rendered Russian-made products relatively cheaper than imports. This
contributed to increased purchases of domestically produced goods and
services as well as facilitating exports.

In 1999 output increased for only the second time since 1991, by an
officially estimated 3.2 percent, regaining much of the ground lost
during the 4.6 percent drop of 1998. The 1999 increase was achieved
despite a year of potential turmoil that included the ousting of 3
premiers and culminated in the New Year's Eve resignation of
President Boris Yeltsin. Of great help was the tripling of international
oil prices in the second half of 1999, raising the export surplus to
US$29 billion. On the negative side, inflation rose to an average 86
percent in 1999, compared with a 28 percent average in 1998. Average
citizens found their
real wages
fall by roughly 30 percent and their pensions by 45 percent. The new
Russian government, under the leadership of Vladimir Putin, gave high
priority to supplementing low incomes by paying back wage and pension
IOUs. However, many investors, both domestic and international, remained
on the sidelines, scared off by Russia's long-standing problems
with
capital flight
, widespread corruption, and newspaper articles on organized crime and
the Russian mafia. The international press gave sensational coverage to
investigations of
money laundering
schemes designed to move ill-gotten gains into safe havens out of
Russia.

The rebound continued in 2000 as the Russian economy grew briskly
throughout the year, far exceeding expectations. Buoyed by the
devaluation
of the ruble and a sharp increase in average oil export prices over
1999 levels,
real GDP
surpassed its pre-1998 crisis level, growing by over 8 percent in 2000.
Growth in industrial output, which reached 8 percent in 1999, further
increased in 2000. The increase in industrial production led to a
reduction in the unemployment rate, with recorded unemployment falling
to just over 10 percent by the end of 2000.

On the negative side, it must be noted that Russia's economic
growth was still largely concentrated in a few sectors. Nor were the
benefits of growth widely distributed throughout the society. More than
one-third of the population of the Russian Federation continued to live
below the poverty line. The social assistance provided by the government
was not sufficient and was not successfully targeted to the poor and
those most in need. In sum, the general quality of the
government's services has deteriorated since 1991. The poor and
the most vulnerable were the most directly affected by this
deterioration.

The declines in industrial production have taken place simultaneously
with a modest but steady growth in the trade and service sectors. These
sectors were underdeveloped during the years of the USSR's
central planning. The majority of Russian manufacturing enterprises
remain uncompetitive if judged by world standards. Output has continued
to fall at medium and large Russian enterprises, while many small
companies and
joint ventures
have grown in output and efficiency. Overall, services have grown to
account for more than 50 percent of GDP, with manufacturing contributing
just slightly less than 40 percent and agriculture accounting for just
under 10 percent. Overall trends indicate that the portion of GDP
accounted for by services and taxes was increasing while industrial
production and manufacturing were decreasing in importance as
contributors to GDP. In December 2000, the Russian parliament (the
Federal Assembly) passed Russia's first post-Soviet balanced
budget.

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